Housing is usually a significant part of a budget. The advantages of homeownership are security, privacy, peace of mind and pride of ownership. Some people also feel that a home is a better environment for raising children than an apartment.
Home ownership also has tax advantages because mortgage interest and property taxes paid on a home may be deductible expenses on the federal income tax return. In some states, homestead laws also protect a person’s home from certain creditors. A home can be a good inflation hedge because houses often appreciate as much as or more than inflation.
However, a home should be considered primarily as a place to live, rather than an investment asset. The big investment required in a house is often the most significant disadvantage of home ownership. Moreover, the investment is relatively illiquid. Another possible disadvantage of home ownership is that home values can decrease, as many homeowners discovered when the housing bubble burst several years ago. The time and money required to maintain a home can also be a disadvantage.
Renting may be advantageous if a person plans to move from a community soon. Renting can be less expensive than paying for closing costs, real estate agents’ fees and maintenance on a home. The problems and delays associated with selling a home can also be avoided. But if a person will remain in a community for some time, homeownership should be considered because the mortgage payment will remain fixed, while rent will generally increase with time.
The 5 Most Important Factors to Consider
In deciding whether to buy or to rent, a person should perform a financial analysis of the following factors:
1. Amount of the monthly rent versus the monthly mortgage payment.
2. Property taxes, the amount of mortgage interest and the individual’s tax bracket because taxes and mortgage interest are deductible.
3. Cost of insurance and maintenance.
4. Lost income on the money used as a down payment.
5. The increase in equity on a home, including reduction of the mortgage principal amount and the home’s appreciation.
Advice for Renting
For those who choose to rent, it is important to choose the rental unit with careful consideration and inspection. It can also be a challenge to objectively compare multiple rentals to each other. That’s especially true for students who may be renting for the first time.
To help with this process, we created a renter’s checklist. The checklist covers all the important elements of the renting process, starting with reviewing the terms of the lease. It also has a detailed section on inspecting an apartment, as well as factors to consider for the surrounding neighborhood. You can download and print this free checklist: INTRO Guide Appendix A- Sample Renter’s Checklist
A conventional mortgage is usually a fixed mortgage, which means the interest rate and amount of each monthly payment are fixed. Conventional mortgages are traditionally not insured or guaranteed by any agency, although now private mortgage insurance is available to insure losses in the event of a default.
The Basics of FHA and VA Mortgages
An FHA mortgage is a loan given by an approved lending institution, and the loan is insured by the Federal Housing Administration. The borrower pays a fee for the FHA loan insurance, but this fee can be amortized over the life of the loan. In the event of default, the FHA will pay the lender for any losses.
VA mortgages are guaranteed by the Veterans Administration. Only honorably discharged Veterans of the U.S. armed forces are eligible for these loans. The VA, like the FHA, sets the interest rates, qualification standards, and down payments required for their mortgage loans. While interest rates for VA and FHA loans are set by these agencies, rates for conventional loans are set by the lending institutions and depend upon money market supply and demand.
More Details About FHA and VA Mortgages
FHA and VA mortgages may be assumable, which means a buyer can take over the existing mortgage and make the monthly mortgage payments to the lending institution without qualifying for a new mortgage. The lender also cannot increase the interest rate or require refinancing of these loans. Most other mortgages contain due-on-sale clauses which require payment of the mortgage balance upon the sale of the property. These clauses force refinancing of the mortgage loan whenever a property is sold.
Are There Advantages to An Assumable Mortgage?
An assumable mortgage can be advantageous to the buyer because the buyer is relieved of qualifying for the mortgage, and the interest rate on the existing mortgage may be below the current market rate. In addition, the buyer can avoid paying several costs that are associated with obtaining a mortgage loan. For example, to obtain most mortgage loans, a borrower must pay an origination fee to the lender for arranging the loan.
The borrower may also pay points, which are essentially a way to increase the lender’s return on the loan in the first year while offering the borrower a slightly lower interest rate. A point is one percent of the mortgage loan amount. On a $100,000 mortgage, one point is $1,000. A borrower must also pay closing costs, which may include title insurance, attorney’s fees, recording fees, survey and appraisal fees, credit reports, and insurance and tax reserves.
In addition to avoiding payment of the origination fee and points, an individual assuming a mortgage can avoid some of the other closing costs associated with purchasing real estate. Note that the assumption of an existing mortgage may not make sense where the interest rate on the existing mortgage is above current market rates or where the existing mortgage balance is relatively small.
Successful budgeting can help an individual anticipate future financial needs and prevent financial problems like those that arise from taking on too many financial obligations and incurring too much debt. A budget is useful in helping an individual to achieve financial goals and can also be a tool for increasing net worth or for achieving financial security.
The Basics of Budgeting
The stages of the budgeting process are estimating income, estimating spending and planning for savings. Income can be estimated using gross income or net income after deduction of items regularly withheld from a paycheck. For a client on a salary or receiving a regular wage, estimating income probably won’t present much of a problem. But for a self-employed person, the fluctuation may require a low estimate of income for budgeting purposes.
Estimating spending is complicated somewhat by certain large expenditures that arise annually or semiannually. Regular deductions or contributions to a savings account may be required to pay for items such as an annual insurance premium or annual assessment of real estate taxes. In budgeting expenditures, some payments like rent or the mortgage are not subject to much immediate reduction. Other items like clothing, recreation and entertainment may be readily controlled. Additionally, one must always take into account the effects of inflation.
Savings should be planned as part of the budget and not considered a residual that will simply materialize if expenditures are controlled. Conscious effort is required to save. Financial planners often recommend saving 5% to 10% of income annually. The exact amount of savings needed to reach goals will be determined as part of the planning process. Arrangements can be made with a bank to transfer a specific amount each month from a checking to a savings account.
9 Rules for Budgets
The following rules can be helpful in preparing budgets:
1. Be reasonable in establishing goals.
2. Budget for fixed expenses like a mortgage payment or rent first.
3. Make saving a priority.
4. Necessities like food, clothing and transportation may be variable expenses but a high priority.
5. Set aside money over many income periods to spread out payment for large annual expenses.
6. Large expenses are not necessarily the easiest to cut.
7. Develop priorities for general categories of expenses and don’t try to account for every penny.
8. Records should be kept of expenditures after the budget is established.
9. Use it to measure and understand actual versus planned results.
If the estimated expenditures and planned savings exceed income, the financial planner and client should review expenditures to see where the expenses can be reduced. The budget should balance. Moreover, the budget will work only if the estimates have been realistic.
One way for planners to help clients access credit at lower interest rates is to teach them how to manage their FICO scores. This score can range from 330 to 850. The higher the score, the better. To get the best interest rates, clients should try to keep their FICO scores at 760 or higher. The score value is based on information from credit reports. Understanding how this information affects the score can provide an opportunity for planners to help clients make the right decisions to increase their FICO scores.
Payment History, Amount Owed and Length of Credit History
Payment history is the largest factor in the score. Planners should make sure clients understand the importance of making payments on time. When students enter college, they will typically apply for their first credit card. Students should do so with the understanding that failing to make timely payments can impact their ability to qualify for other types of credit like auto and home loans. This impact can continue well into the future.
The second major factor affecting the FICO score is the amount that’s owed. It’s an assessment of whether or not a borrower might already be overextended on credit. Being overextended means the borrower may have borrowed so much that he or she is unable to make the payments required on this amount of debt. Utilization affects the score positively if credit cards are used periodically and paid on time, but there is no effect on the score if someone has a credit card available but never uses it.
The longer the credit history, the better the score. In the example of the college student getting his first credit card and making timely payments, he’s also increasing his credit score for buying a home in the future by having a longer credit history from the credit card account.
Types of Credit and New Credit
Ten percent of the FICO score comes from looking at the types of credit that are used. These types include credit cards, retail cards, installment loans, finance company accounts and mortgage loans. Having a credit card and using it responsibly provides a higher score than not having any credit cards at all.
The final category that affects the FICO score is new credit. Opening several accounts in a short period of time can indicate a higher credit risk and will lower the score.
Checking a Credit Score
When a consumer checks his or her own credit score, there is no impact on the score, and it is recommended that clients check credit reports on a regular basis to identify and correct any errors and to ensure that there has not been an identity theft situation. Every individual is entitled to one free copy of the credit report from each of the three credit bureaus each year. A good practice to monitor activity throughout the year by requesting a report from a different company every four months.
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